by When you are new to purchasing stock and forming your portfolio it can be a bit overwhelming. People advise you on overall strategies of risk, portfolio allocation and then you might get blurry eyed looking at the 1,000’s of companies you could purchase. While we certainly are advocates of you just need to buy something to overcome the anxiety of information overload we have found that defining your goals and approach for a given stock purchase can help you to make the purchase with confidence.
Investing in Stocks for Long Term Growth
When you are purchasing stock for the long haul we would encourage you to look farther into the future than you might expect. World renowned investor, Warren Buffett has shared that “if you aren’t comfortable owning a stock for 10 years then you shouldn’t own it for 10 minutes” and we certainly couldn’t argue with that advice.
For those new to stock investing 10 years can seem like an unreal amount of time. When you analyze stocks over a period of a decade you will see that this period of time allows you to overcome dips in the market and when it is a good company you will notice a consistent upward trend. Take for example, Starbucks, which we shared in our post about investing in companies that you know. Looking at the Starbucks chart, seen below, you can see a strong upward trend. Now envision that you purchased shares 10 years ago at $20 and you hold them today at well over $100 per share…that is quite a gain!
Of course no stock is a straight line increase, there are minor dips throughout the time period but the key is when you know you purchased it for long term growth you can hold on to your shares with confidence.
Investing in Stocks for a Strong Dividend Yield + Reinvest
Approaching a stock buy with the goal of enjoying strong dividends and then reinvesting those dividends helps you to evaluate your purchase of a stock through a different lens than simply looking for long term growth, although at times these might also be stocks you hold for the long term. If this is the approach you are going to take to purchasing a stock for your portfolio we invite you to consider aspect such as the following:
- History of Dividend Increase – A history of dividend increases generally speaks to a strong balance sheet as when the company increases it they know that is going to be an ongoing commitment. If you are considering a strong dividend yield stock to hold for the long term, looking at their dividend increase over the same 10 year history will have you seeing if you can count on future income.
- Strong Yield – A “strong yield” is a relative term as markets change; however, we tend to look at the yield of a stock when compared with investments that range bonds to even interest rate yields on bank accounts as a form of comparison. Traditionally companies don’t stop their dividends (unless there is a major crisis) so it is fair to compare them with conservative investments to see how much above a guaranteed yield they perform. For example take a 1 year CD interest rate yield in February 2021 at .65%. Now take the dividend yield of AT&T (T) on February 2nd 2021 with a stock price of $28.54 their dividend yield is 7.29%…that is more than 7x over the CD! That would be a strong yield in our book.
When you can enjoy a strong dividend yield and you have seen a history of dividend growth then you also can enjoy the benefits of compounding by reinvesting your dividends. If you opt for reinvesting your dividends into the same stock you can slowly grow your volume of shares over time without adding any new funds to your account. By the time you are satisfied with your volume of shares you can always opt-out of reinvesting the dividends and enjoy the income instead.
Purchasing a Stock for Short Term Gains
Purchasing a stock for short term gains are what movies like “Wolf of Wall Street” and “Wall Street” glamourize. You put in a relatively modest amount of money and in just days or maybe weeks you see yourself headed down the Ferrari dealership…ok maybe a little extreme but you get the point. When we say short term gains we recognize that the tax code identifies this as anything less than a 1 year holding period but we have found that most people want to hold far shorter than a year.
Short term gains can be incredibly exciting but they can also have nearly the same risk factor as going to Las Vegas. Remember if it was easy to make 80% every day on a stock…everyone would do it. If you have the goal of purchasing a stock for short term gains please consider the following:
- % of Portfolio – These investments should represent 10% or less of your portfolio as, by their very nature, they are higher risk.
- Set a Stop Loss – Since these stocks can fall dramatically consider putting in a stop loss order. A stop loss order executes a sale of stock at a certain price helping you to minimize your losses.
- Set a Target Gain – This is perhaps the hardest as people don’t want to miss out on “more growth”. When you are looking at short term gains, set a % that you would be happy with (say 60%-80%) and when it hits your number sell and don’t look back. Sure the stock might climb more but it could also fall which means be confident in the number you decide on and enjoy it.
Growing your stock portfolio will take greater and greater fear management as you see the dollars grow larger; however, understanding your approach to each purchase will have you feeling good about “why” you are making a purchase which helps you to avoid being swayed by the overall volatility of the market.
